Washington, D.C., lawmakers have bills in play that could provide a carrot — or a stick — for lenders and loan servicers to participate in the Bush administration’s rate-freeze plan.
Legislation that would allow bankruptcy judges to modify the terms of Chapter 13 debtors’ mortgage loans could serve as a stick for lenders to conduct their own workouts, rather than have them imposed on them by a court.
The Center for Responsible Lending supports that approach, saying it has the potential to help more borrowers than the Bush administration’s voluntary rate-freeze plan, announced Thursday (see Inman News story). But the mortgage lending industry argues that changing the bankruptcy code to allow judges to conduct “cram downs” would raise the cost of borrowing for all.
Another recently introduced bill would shield loan servicers who engage in workouts with borrowers from lawsuits by investors in securities backed by loans.
One motivation for the Bush administration’s agreement with the “HOPE NOW” coalition of major lending industry companies was to address the reluctance of some loan servicers to modify loan terms to prevent foreclosures because of the fear of such lawsuits.
But federal regulators questioned whether one bill’s attempts to provide such protection are desirable or enforceable.
Both proposals were the subject of separate House and Senate committee hearings this week.
Bankruptcy “cram downs”
The Senate Judiciary Committee Wednesday debated legislation that would amend the bankruptcy code to allow judges to rewrite the terms of mortgage loans on owner-occupied homes.
Senate Bill 2136, introduced Oct. 3 by Sen. Richard Durbin, D-Ill., would amend federal bankruptcy law to allow judges to modify loans secured by a Chapter 13 debtor’s principal residence, allowing them to make payments at a fixed annual percentage rate over a 30-year period. Durbin’s bill would also allow bankruptcy judges to “strip down” the amount of a mortgage to the value of the home without the consent of the mortgage holder.
Sen. Arlen Specter, R-Penn., has introduced a competing bill to Durbin’s, SB 2133, which would require the lender’s consent to reduce the amount owed on a mortgage.
Bankruptcy courts already have the power to restructure troubled borrower’s auto loans and credit card debt. But critics like the Mortgage Bankers Association say allowing bankruptcy judges to rewrite the terms of mortgage loans would undermine confidence in the ability of lenders to collect payments, and increase interest rates on mortgage loans by up to 2 percent.
Unlike a car loan — in which the property serving as collateral for a loan decreases in value over time — mortgages are backed by property that, in the long run, tends to appreciate. So lenders argue that a judge’s decision to strip down a mortgage loan to reflect the current value of a bankrupt debtor’s home would amount to a “taking” of their collateral.
Durbin’s bill could also encourage more borrowers facing foreclosure to file for bankruptcy, critics said, increasing the case burden of bankruptcy judges and forcing them to deal with complex issues such as home valuations and mortgage interest rates.
But supporters of Durbin’s bill said bankruptcy judges are already proficient at rewriting the terms of auto loans and credit card debt, and that stemming the tide of foreclosures is in the best interest of lenders and the economy.
Mark Zandi, chief economist of Moody’s Economy.com, said he expects 2.8 million mortgage loan defaults in 2008 and 2009, with 1.9 million homeowners going through the entire foreclosure process and ultimately losing their homes.
Zandi said Durbin’s bill could allow 570,000 homeowners to avoid foreclosure, a number based on an analysis of homeowners who face a first payment reset through the end of the decade and who meet the new, tougher requirements for Chapter 13 bankruptcy protection adopted by Congress in 2005.
“The housing market downturn is intensifying and mortgage foreclosures are surging,” Zandi said, warning of a “self-reinforcing negative dynamic” of mortgage foreclosures, house price declines, and more foreclosures. “The odds of a full-blown recession are very high. There is no more efficacious way to short-circuit this developing cycle and forestall a recession than passing this legislation.”
Zandi dismissed arguments that the bill would raise the cost of borrowing or disrupt the secondary market for mortgages, saying lenders stand to lose more if the loans that would become eligible for modification by bankruptcy judges were to foreclose instead.
“Given that the total cost of foreclosure to lenders is much greater than that associated with a Chapter 13 bankruptcy, there is no reason to believe that the cost of mortgage credit across all mortgage loan products should rise,” Zandi said.
U.S. Bankruptcy Court Judge Jacqueline Cox, who adjudicates bankruptcy filings in Northern Illinois, said that the disparate impact of the mortgage crisis on African Americans and Latinos makes passage of the Durbin “critical.” She said bankruptcy court judges would not be overwhelmed by the process of modifying home loans, which would include determining the current market value of each home.
Thomas Bennett, a federal bankruptcy court judge in Alabama, testified that the changes proposed by Durbin would not help borrowers who were not willing or able to file for bankruptcy, and could have broader, unintended consequences on credit markets.
Bennett urged lawmakers to step back for 60 to 90 days and “leave everything where it is” in order to get a broader picture. He said a temporary moratorium on foreclosures or an interest rate freeze could give them time to consider the bill’s implications.
‘Safe harbor’ from lawsuits
At another hearing Thursday, the House Financial Services Committee debated a HR 4178, a bill introduced Nov. 14 by Rep. Mike Castle, R-Del., to protect loan servicers who engage in workouts under criteria established by the bill.
The bill would provide a “safe harbor” from lawsuits for loan servicers or other note holders who work with borrowers to restructure subprime loans in default, or loans where default is “imminent or reasonably foreseeable.” The safe harbor would also apply when workouts would maximize “net present value” of a loan.
The bill would apply to subprime loans made after Jan. 1, 2004. The retroactive application of the bill “could create additional anxiety in the mortgage markets about the reliability of legal obligations upon which investors’ expectations are based,” said Comptroller of the Currency John Dugan in his prepared testimony.
He questioned whether the bill would create new qualms for investors in mortgage-backed securities. “A loss – or even a significant diminution – of investor confidence in this market could adversely affect the flow of funds for housing credit for some time to come,” Dugan said.
FDIC chairman Sheila Bair called the bill’s goal of stimulating loan modifications by providing legal protection for loan servicers “laudable.” But Bair said that as written, the bill could be challenged on Constitutional grounds, as it “would appear to override existing contracts.”
Bair said that if Congress is determined to pass such a bill, it should contain language stipulating that “servicers have a duty to maximize the net present value of a loan pool for all investors and parties having an interest in the pool, not to any individual party or group of parties.”
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